Assume you have just been hired as a business manager of Pizza Stop, a pizza restaurant...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Assume you have just been hired as a business manager of Pizza Stop, a pizza restaurant located adjacent to campus. The company's EBIT was $5,000 during 2021, and since the college's enrollment is capped, EBIT is expected to remain constant (in real terms) over time. Since no expansion capital will be required, Pizza Stop plans to pay out all earnings as dividends. The firm is currently financed with all equity; it has 1000 shares outstanding with a Book Value at $10 per Share. When you took your finance course at the college, you learnt that most firm's owners would be financially better off if the firms used some fixed costs (operating leverage) and some debt (financial leverage). When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's financial analysts the following information: 2021 Data: Sale - 1400 units; Price per unit - $15; Variable Cost Per Unit - $10; Fixed Cost - $2,000; EBIT - $5,000 Question 1 - Please explain the impact of operating leverage on the break-even and the profitability of the company. Use the above information to build your argument. (2 Marks) Now, to develop an example which can be presented to Pizza Stop's management to illustrate the effects of financial leverage, consider two hypothetical situations: Pizza Stop continues to use zero debt, and as an alternative Pizza Stop raises $5,000 of debt at an interest rate of 8% and use this money to buy back 5000 shares. Pizza Stop has $10,000 in assets that remains unchanged in both the situations, a 30 percent tax rate, and an expected EBIT of $5,000. Question 2 - Use the above hypothetical situations to explain the concept and effect of financial leverage on the performance of the company from the owners' point of view. Explain your logic with calculations of EBIT, ROE, DFL, or any other matrices (4 Marks) Assume you have just been hired as a business manager of Pizza Stop, a pizza restaurant located adjacent to campus. The company's EBIT was $5,000 during 2021, and since the college's enrollment is capped, EBIT is expected to remain constant (in real terms) over time. Since no expansion capital will be required, Pizza Stop plans to pay out all earnings as dividends. The firm is currently financed with all equity; it has 1000 shares outstanding with a Book Value at $10 per Share. When you took your finance course at the college, you learnt that most firm's owners would be financially better off if the firms used some fixed costs (operating leverage) and some debt (financial leverage). When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's financial analysts the following information: 2021 Data: Sale - 1400 units; Price per unit - $15; Variable Cost Per Unit - $10; Fixed Cost - $2,000; EBIT - $5,000 Question 1 - Please explain the impact of operating leverage on the break-even and the profitability of the company. Use the above information to build your argument. (2 Marks) Now, to develop an example which can be presented to Pizza Stop's management to illustrate the effects of financial leverage, consider two hypothetical situations: Pizza Stop continues to use zero debt, and as an alternative Pizza Stop raises $5,000 of debt at an interest rate of 8% and use this money to buy back 5000 shares. Pizza Stop has $10,000 in assets that remains unchanged in both the situations, a 30 percent tax rate, and an expected EBIT of $5,000. Question 2 - Use the above hypothetical situations to explain the concept and effect of financial leverage on the performance of the company from the owners' point of view. Explain your logic with calculations of EBIT, ROE, DFL, or any other matrices (4 Marks)
Expert Answer:
Answer rating: 100% (QA)
Question 1 Impact of Operating Leverage on Breakeven and Profitability Operating leverage refers to the degree to which a companys costs are fixed versus variable A high level of operating leverage me... View the full answer
Related Book For
Corporate Finance A Focused Approach
ISBN: 978-1305637108
6th edition
Authors: Michael C. Ehrhardt, Eugene F. Brigham
Posted Date:
Students also viewed these finance questions
-
Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The company's EBIT was $50 million last year and is not expected to grow. The firm is...
-
Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The company's EBIT was $50 million last year and is not expected to grow. The firm is...
-
According to Dr. Grant, creatives are people who ________. A. Are procrastinators B. Act on multiple ideas C. Plan out each detail D. Are highly confident with no doubts about their success
-
Reliable gearing currently is all-equity-financed. It has 10,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a...
-
Examine the following partially completed payroll check stub. The employee, Melanie Galvin, is single and claims one allowance. What amount should be deducted for: 1. Medicare tax? 2. Social Security...
-
True or False: Multiple roots can exist when using IRR and MIRR methods.
-
The comparative financial statements of Optical Solutions Inc. are as follows. The market price of Optical Solutions Inc. common stock was $60.00 on December 31, 2010. InstructionsDetermine the...
-
K Use appropriate formulas to find (a) the perimeter and (b) the area of the figure. 8.8 m 5 m 5.2 m 7 m (a) The perimeter is (Type an integer or a decimal.)
-
Cullumber Company uses a periodic inventory system and reports the following for the month of June. Date Explanation Units Unit Cost Total Cost June 1 Inventory 130 $5 $ 650 12 Purchases 388 6 2,328...
-
A stationary car is stopped at a traffic light. When the light turns green at t = 0, a truck with a constant speed of 25m/s passes the car. The car uniformly accelerates to its top speed (30m/s) in...
-
What happens when 100 bits arrive all at once at the start of each second? The departure rate can never exceed 750bps. What is the average and maximum occupancy of the queue? What is the average and...
-
Suppose that a certain population has a growth rate that varies with time and that this population satisfies the differential equation dy y (0.5 sint) + dt NOTE: Round your answers to two decimal...
-
Identify at least two legislation relevant to risk management and explain how Legislation Affects Risk Management Processes in the Organisation? Identify at least two regulations relevant to risk...
-
Question 1: a. Identify McDonald's corporate social responsibility practices and explain how McDonald's Australia objectives are building their corporate social responsibility culture. b. Identify...
-
What evidence can you give that sunspots are magnetic?
-
Let (x) = x 2 - 9, g(x) = 2x, and h(x) = x - 3. Find each of the following. (((--) 2
-
You have just graduated from the MBA program of a large university, and one of your favorite courses was "Today's Entrepreneurs." In fact, you enjoyed it so much you have decided you want to "be your...
-
Williams & Sons last year reported sales of $12 million, cost of goods sold (COGS) of $10 million, and an inventory turnover ratio of 2. The company is now adopting a new inventory system. If the new...
-
Refer to Problem 12-1. Return to the assumption that the company had $5 million in assets at the end of 2016, but now assume that the company pays no dividends. Under these assumptions, what would be...
-
Let \(\left\{x_{n}ight\}_{n=1}^{\infty}\) be a sequence of real numbers defined by \[x_{n}=\left\{\begin{array}{rl}-1 & n=1+3(k-1), k \in \mathbb{N} \\0 & n=2+3(k-1), k \in \mathbb{N} \\1 &...
-
Let \(\left\{x_{n}ight\}_{n=1}^{\infty}\) be a sequence of real numbers defined by \[x_{n}=\frac{n}{n+1}-\frac{n+1}{n},\] for all \(n \in \mathbb{N}\). Compute \[\liminf _{n ightarrow \infty}...
-
Each of the sequences given below converges to zero. Specify the smallest value of \(n_{\varepsilon}\) so that \(\left|x_{n}ight| n_{\varepsilon}\) as a function of \(\varepsilon\). a....
Study smarter with the SolutionInn App